Landlord and Investment Behaviour

Resume:Is the Provision of Rental Housing Economically Efficient?In the literature different arguments have been put forward that the private rented sector is more or less economically efficient than the owner-occupied sector.

Some of the arguments put forward for higher efficiency in the rented sector are that private landlords could be more efficient in carrying through administration, maintenance and improvement by greater professionalism and economics of scale. It could also be expected that landlords often have a superior credit rating compared to most individual homeowners, which could result in smaller capital costs. The extent to which these advantages for private renting are present depends, however, on what kinds of landlords are active in the sector. Studies in many countries have shown that the majority of private landlords

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Is the Provision of Rental Housing Economically Efficient?

In the literature different arguments have been put forward that the private rentedsector is more or less economically efficient than the owner-occupied sector.Some of the arguments put forward for higher efficiency in the rented sector are thatlandlords could be more efficient in carrying through administration, maintenance andimprovement by greater professionalism and economics of scale (Linneman, 1985;Whitehead, 1996). It could also be expected that landlords often have a superior creditrating compared to most individual homeowners, which could result in smaller capitalcosts.

The extent to which these advantages for private renting are present depends,however, on what kinds of landlords are active in the sector. Studies in many countries(Lundstr¨om & Gustafsson, 1985; Allen & McDowell, 1989; Crook & Kemp, 1996;Yates, 1996; Skifter Andersen, 1998) have shown that the majority of private landlords most often are individuals, many with a single property. In a study of the private rentedsector in Britain, Crook and Kemp (2002) thus concluded that:Although the sector has grownsignificantly in the last decade, it is still a ‘cottageindustry’ owned and managed by small scale individual landlords, fewof whomhave any qualifications in property, let alone in the letting business. Very fewcan either achieve economics of scale in managing their holdings or managemarket risk through a geographically and otherwise diversified portfolio.Crook and Kemp (2002) explain the lack of interest from institutional investors inBritain by the structure of the housing stock with many small lot sizes and properties,but also by investors regarding investments in residential property as comparativelymore risky. One of the causes mentioned is a lack of market information about thesector and on rents and returns in particular (Yates & Wood, 1996). The size andquality of housing varies considerably and prices differ between localities, whichmakes it difficult to compare rents and decide what rent could be obtained for aparticular dwelling.

A classic argument for less efficiency is what Henderson and Ioannides (1983)called the ‘fundamental rental externality’, which arises from the separation of ownershipand the use of the dwelling. A consequence of this externality is that tenantshave an incentive to ‘over utilize’ their housing in the belief that landlords cannotcollect ex post for the full damage the tenants cause because it is either not readilyobservable or not provable in court. Another problem could be tenants that cease topay the rent on time. The result is that landlords, to cover their opportunity costs,have to charge higher rents ex ante to account for this excessive utilization. Anotherway to put this is to say that renters tend to take less care of their dwellings, whichtends to increase costs of housing provision in the rented sector. This was also shownin a study by Galster (1983), who tested the effect of tenure on maintenance, using asample of 559 houses in Wooster, Ohio. He found that owners were between 58 and132 per cent more likely to perform maintenance and 84 to 92 per cent less likely tohave structural problems.

Landlords in principle could try to preclude this problem with ‘expensive’ renters

by trying to avoid renters who are inclined to wear out their dwellings. But in practiceit could often be difficult to foresee those renters who will take good care of theirdwelling and those who will not (Green, 2001). The landlords who have the beststrategy for selecting renters could, however, have the best possibilities for providingcheaper housing services or gain higher profits.

Moreover, buildings with rental property – at least in Denmark – are often occupiedby several (different) households who perhaps have significant difference in tastes.So the property has to be dealt with flexibly by the landlord with alert attention tochanging market opportunities (Rothenburg et al., 1991). It can be more costly todifferentiate the housing services from dwellings in the same building than to trea all dwellings alike, but sometimes it could be necessary to adjust the supply from thesame estate to different kinds of demands. Housing tastes are rather individualistic.Therefore, the kind of investment a particular occupant favours most often differsfrom what would maximize the market value of the premise (Hubert, 2005 ). A riskfor the landlord, if he/she does not have a varied and flexible supply of dwellings, isthat some of his flats for shorter or longer periods could be vacant. The risk for vacantdwellings could lead to that the landlord has to collect higher rents to cover possiblelosses as a result of missing rents.

Also higher rates of turnover in rented housing can imply higher costs; at least costsfor administration, but sometimes also higher maintenance costs, if the landlords haveto have the dwellings done up every time they get a new tenant. This could imply amaintenance sequence that is not economically optimal.

Moreover, the demand fluctuates in the rental market. It can be asserted that demandfor rented housing – and especially private renting – to some extent is a residual of thedemand for owner-occupied housing (Di Pasquale&Wheaton, 1992). This means thatthe demand for rented housing decreases in periods when demand for homeownershipis increasing. It is thus an experience from the United States that rents have stagnatedand vacancies increased in periods with high economic growth and increased housingdemand, because this increased demand has implied a shift in demand from rentedto owner-occupied housing (Di Pasquale & Wheaton, 1992; Skifter Andersen, 1993).Finally, sudden changes in housing policy have changed the economic conditions forprivate renting in ways that were not very easy to foresee. Therefore, investments inresidential rental property could be quite risky. These risks imply that landlords haveto take relatively higher rents.

Literature on Types of Private Landlords and their Motives for Investing

in Private Renting

Some of the more detailed studies show that private landlords differ very much intheir motives for investing in private renting and in their characteristics as economicagents.

In their study, Allen andMcDowell (1989) identified six different kinds of landlordsin England. They paid attention to the differences between these groups concerningtype and size of the landlords’ capital, their sources of finance, their investmentpractices and their relationships with the tenants and their property. Different kinds ofeconomic and other motives for investing in private renting were identified. Besideseconomic return on operating the properties other motives were identified such asavoiding cash-flow problems, speculation in capital gains, provision of cheap housingfor special groups or employees and personal attachment to one or more properties.Based on case studies, Allen and McDowell analyzed these six types of landlords andshowed pronounced differences in their motives and behaviour.In other British literature (Thomas & Snape, 1995) a main division of privatelandlords has distinguished between: sideline investors, who do not let property as afull-time job or as their core business but as a sideline interest; business landlords, wholet property as their main business, and institutional landlords, such as the church,charities and government departments, who are non-profit organizations with the taskof providing good and cheap housing for certain groups. Only 15 per cent of privatelandlords in Britain are business landlord (Kemp, 2004); 22 per cent are institutionsand 63 per cent are sideline investors, of which 18 per cent are characterized as ‘noninvestors’,

who do not view their purchase of the property as an investment, but haveother reasons. Sideline investors hold 74 per cent of the dwellings, business landlords17 per cent (of which 11 per cent are property companies) and institutions 10 per cent(Crook & Kemp, 2006 [OPDM]).

Kemp (2004) also referred to a study of landlords’ motives for investment in privaterenting. It showed that only 57 per cent had invested for economic reasons, while 43per cent had other reasons like to live in the property, to help someone out, to houseemployees and other. Only four per cent invested solely for capital growth.An earlier Danish study on private landlords in Denmark and their motives forinvestments in maintenance and improvement was carried out in the beginning of the1990s (Skifter Andersen, 1998). The study only concerned properties with three ormore dwellings in the housing stock built before 1950. The Danish study showed apicture of landlordism, which in many ways is similar to the one, described by Allenand McDowell (1989). Six types of motives were identified in the Danish study thatguides the way landlords run their properties.

1. Long-term economic motives: This is the kind of motives that in economic theoryis expected from investors in rental housing. The greatest importance is attachedto the long-term profitability and the administration of the property and the moneyinvested in maintenance and improvements are guided by this motive. It does notmatter if there is a budget deficit for some years if the perspective for future gainsis good.

2. Short-term economic motives: For some landlords it is important that there bean economic surplus from the property every year. This could be because theycannot raise money to finance a temporary deficit or because they are dependenton an income from the property to live on. This motive guides their investment andexpenditure on the property. In an economy with inflation short-term economicmotives tend to diminish investments.

3. Speculative economic motives: Rental housing is seen as just one of a number ofpossibilities for speculative investments. Expectations of short-time changes inreal estate prices are the basis for such speculation while long-term profitability ofthe estate has little importance, except for its consequences for real estate values.

4. Income from doing building work: For building firms or landlords, who are connectedwith building firms or who are tradesman themselves, there is a strong incentive to buy and rehabilitate properties with the purpose of obtaining work.For small-scale landlords and tradesmen there is the possibility of escaping taxationof this income by do-it-yourself work.

5. Property as a personal possession: For some landlords their property is not justan investment object but also a kind of personal belonging. They attach a separateimportance to the appearance and quality of the house and dwellings, and it isimportant for them to be able to control it. The property is a kind of a personalproject where other motives than the strictly economic reasons have a considerableimportance.

6. Service or social motives: For different reasons it is important for some landlordsthat the housing services provided for their tenants are of a good quality or ascheap as possible. These motives result in housing that is cheaper or better thanwould be economically optimal if profitability were the only motive. The reasonscould be that the landlord has a kind of non-profit status or is an organisation thatcompletely or partly has an objective to provide housing for certain groups. Thisalso includes companies whowant to provide accommodation for their employees.The study (Skifter Andersen, 1998) concluded that the motive normally ascribedto private landlords in economic theory – long-term considerations of incomes andcapital gains on the property – are only important to some types of landlords. For otherlandlords the short-term economy and speculative possibilities plays a dominant role.Also non-economic motives as property relations and service provision are importantto many landlords. Below we will try to show the extent of these motives amongDanish landlords using new data from a survey among Danish landlords.

Original article at: http://boligforskning.dk/sites/default/files/ejhp2007.HSA[1].pdf